Bank revenue is rising. It is rising faster when governments guarantee their funding – but it is nonetheless rising pretty well across the board. The explanation for that rise is at best in part taxpayer subsidies. But that is not the only explanation. The competitive dynamics are far more important in explaining why revenue should rise.

Why is it that people have given up believing that competition is the main determinant of margins?

7 comments:

You don't seem to grasp the mood in America, at least this American. I want to see Citi and BofA have the opportunity to die for their mistakes. Let's remove the Bernancke-Geither put and see how they do. That's free enterprise. If they can build a new house with their increasing margins before the old one crumbles, great. If not, so long pal.

I'm with Nemo - boycott Citi and BofA until the free market is restored.

Banks have woken up to the new liquidity situation, and started charging a liquidity premium. If they go out in the market for money longer term they don't pay flat or a small spread anymore, they pay much more. So they are charging their customers alike.However, now in the short term they can still fund themselves cheaply due to government support and deposits, so that spread is increasing dramatically. Also libor is still high, which helps the funding side.The cost of the long term funding will trickle through more slowly and show up later, depending on further developments

For any given risk-free rate, the supply of deposits depends on two components: the deposit coupon and the risk of default on the deposit obligation.

So you argue that coupons are set competitively, and that is correct.

However, the expected risk of default (on the deposit obligation) is equal for all banks under FDIC insurance. It is not set "competitively" in the sense that a lower risk of default, in aggregate, does not result in a higher supply of deposits.

Assume the system is solvent overall. If you eliminated the insurance and ignore contagion risk, then its possible the aggregate perceived default risk would not change: deposits would just migrate to solvent firms, and the supply of deposits would be constant.

However, if there is a fear that the system is not solvent, then eliminating the insurance causes the perceived default risk to rise and the expected return to fall. Assuming a positively sloped supply curve, the supply of deposits would therefore also fall. Deposit rates would have to rise for total deposits to remain constant.

So you're making the argument that the system is solvent overall, and therefore, deposit rates are competitively set, aggregate default risk is non existent, and FDIC insurance is unnecessary. Its plausible, but even if true, it ignores information asymmetry (a bank may know its solvent, but its depositors don't); and it ignores contagion effects that occur as a consequence of deposits migrating from bad to good banks.

I think I understand where you're coming from, and I simply disagree that the system is largely solvent, or that we could even know if that were true. I the absence of more transparency, I think its rational for depositors to bring down their expected returns if FDIC insurance is lifted. Therefore, assuming a positively sloped supply curve, deposit rates would rise in aggregate, or the supply of credit would fall.

It is clear to me that banks in Australia and probably overseas too, are expanding margins for the reasons stated.In particular aussie banks are picking up market share to the point that they are belatedly cutting dividends to get new capital to finance the growth of business at higher margins that is going on due to foreign bank exits plus fringe bank demises.To be sure part of their need for more capital is due to RWA impairment but according to JBWERE Reseach Banks in Aussie may need up to $5.5b in new capital of which only $1.5b is due to impairment and the rest GROWTH at these higher margins.In this market can you find any other business that is growing and expanding its margins?Most capital raisings are to save businesses presently not to grow them and strangle the competition.The only negative is how much more impairmnet will happen due to the banks lagging in their write offs.Now that they are cutting divs rather than continuing the DRP fiction the turning point may be approaching where you can be a bit more confident about bank share prices and so buy for the 7% + yields they will offer with divs at more sustainable levels.

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